Management Control

(session 6)

Variances I
 Managerial Accounting & Processes

Plan Do / Act Check

Learning Control

Feedback involves managers examining past

performance and systematically exploring
alternative ways to make better informed
decisions in the future.
2
 Variance

Actual Result Budgeted Result

Variance

The difference between an actual result and a

budgeted (or planned) result
 Budget variances
Actual Budget Total
€ € variance
Sales 2 526 725 2 761 760 235 035 U
Raw materials 1 824 000 2 000 000 176 000 F
Labour 207 000 220 000 13 000 F
Supplies 152 450 148 949 3 501 U
Advertising 78 625 65 165 13 460 U
Miscellaneous 3 320 3 000 320 U
Depreciation expenses 24 000 24 000
Insurance 9 780 9 400 380 U
Taxes 10 940 11 700 760 F
Rent 72 000 72 000
Energy 26 982 23 273 3 709 U
Management fees 98 000 95 000 3 000 U
Profit (EBIT) 19 629 89 273 69 645 U

« U » or « A » respectively for « Unfavorable » or « Adverse » Depending on

the impact on
« F » stands for « Favorable »
profit
Introduction to profit variance
Actual Budget Total
€ € variance
Sales 2 526 725 2 761 760 235 035 U
Raw materials 1 824 000 2 000 000 176 000 F
Labour 207 000 220 000 13 000 F
Supplies 152 450 148 949 3 501 U
Advertising 78 625 65 165 13 460 U
Miscellaneous 3 320 3 000 320 U
Depreciation expenses 24 000 24 000
Insurance 9 780 9 400 380 U
Taxes 10 940 11 700 760 F
Rent 72 000 72 000
Energy 26 982 23 273 3 709 U
Management fees 98 000 95 000 3 000 U
Profit (EBIT) 19 629 89 273 69 645 U
Sales volume
(in units) 800,000 1,000,000
Total variance = Price variance + Quantity variance + Volume variance
 Flexed Budget

Sales Variable
Raw materials Variable cost
Labour Variable cost
Supplies Variable cost
Advertising Fixed cost
Miscellaneous Fixed cost
Depreciation expenses Fixed cost
Insurance Fixed cost
Taxes Fixed cost
Rent Fixed cost
Energy Variable cost
Management fees Variable cost
Profit (EBIT)
 Flexed Budget
Actual Flexed Budget Budget Total
(in €) (in €) (in €) variance
Sales 2 526 725 2 761 760 235 035 U Variable
Raw materials 1 824 000 2 000 000 176 000 F Variable cost
Labour 207 000 220 000 13 000 F Variable cost
Supplies 152 450 148 949 3 501 U Variable cost
Advertising 78 625 65 165 13 460 U Fixed cost
Miscellaneous 3 320 3 000 320 U Fixed cost
Depreciation
expenses 24 000 24 000 Fixed cost
Insurance 9 780 9 400 380 U Fixed cost
Taxes 10 940 11 700 760 F Fixed cost
Rent 72 000 72 000 Fixed cost
Energy 26 982 23 273 3 709 U Variable cost
Management fees 98 000 95 000 3 000 U Variable cost
Profit (EBIT) 19 628 89 273 69 645 U

Sales volume
(in units) 800,000 1,000,000
 Flexed Budget
Actual Flexed Budget Budget Total
(in €) (in €) (in €) variance
Sales 2 526 725 2 209 408 2 761 760 235 035 U
Raw materials 1 824 000 1 600 000 2 000 000 176 000 F VC
Labour 207 000 176 000 220 000 13 000 F VC
Supplies 152 450 119 159 148 949 3 501 U VC
Advertising 78 625 65 165 65 165 13 460 U FC
Miscellaneous 3 320 3 000 3 000 320 U FC
Depreciation
expenses 24 000 24 000 24 000 FC
Insurance 9 780 9 400 9 400 380 U FC
Taxes 10 940 11 700 11 700 760 F FC
Rent 72 000 72 000 72 000 FC
Energy 26 982 18 618 23 273 3 709 U VC
Management fees 98 000 76 000 95 000 3 000 U VC
Profit (EBIT) 19 628 34 365 89 273 69 645 U
Sales volume (in
units) 800,000 800,000 1,000,000
In the flexed budget for the VC:
Budgeted amount per unit X actual sales volume
Sales volume & Sales price var.

Sales volume variance = Flexed budget profit - Original budget profit

It indicates the variance due to an error in forecasted sales volume
Sales vol. variance = 34,365 – 89,273 = 54,908 U

Sales price variance = (Actual selling price - Budgeted SP) x Actual quantity
It indicates the variance due to an error in the budgeted selling price
Sales price variance = (2,526,725/800,000 – 2,761,760/1,000,000) x 800,000
= (3.158… - 2.762…) x 800,000
= 317,317 F

Out of the total variance of 69,645 U; we have already explained 54,908 U

because of lower sales volumes and 317,317 F because of better selling prices…

The remaining 332,054 U variance to be explained is coming from costs sub-

variances (cf. next slides). We don’t have the information to proceed further with
this example. 9
 Variable costs sub-variances
Cost = Price x Quantity
Total variance = Budgeted cost - Actual cost
Total variance = Price variance + Quantity variance + Volume variance
Volume variance =
Price variance = (Budgeted price - Actual price) x Actual quantity
= (BP - AP) x AQ
Quantity var. = (Flexed quantity - Actual quantity) x Budgeted price
= (FQ-AQ) x BP

Price variance Quantity variance

(BP - AP) AQ (FQ - AQ) BP

Raw materials Price variance Usage variance

Direct labour Rate variance Efficiency variance
Variable overheads Expenditure variance Efficiency variance
 Purpose of variance analysis

Variance analysis involves:

– 1. Comparison of actual results with the budget
– 2. Determination of the reasons why variances
have arisen
– 3. Search for corrective actions
• It does not indicate good or bad performance – this
requires further analysis
Introduction to cost variance
Actual Budget Total
€ € variance
Sales 2 526 725 2 761 760 235 035 U
Raw materials 1 824 000 2 000 000 176 000 F
Labour 207 000 220 000 13 000 F
Supplies 152 450 148 949 3 501 U
Advertising 78 625 65 165 13 460 U
Miscellaneous 3 320 3 000 320 U
Depreciation expenses 24 000 24 000
Insurance 9 780 9 400 380 U
Taxes 10 940 11 700 760 F
Rent 72 000 72 000
Energy 26 982 23 273 3 709 U
Management fees 98 000 95 000 3 000 U
Profit (EBIT) 19 629 89 273 69 645 U

Cost variance = Price variance + Quantity variance + Volume variance

 Variable direct costs variances

Total variance
1st step: calculate budget

2nd step: calculate total variance

Standards
3rd step: analyze actual cost

Raw Materials Vol. UsageU.Price Cost

Budgeted cost 1,000 2.00 1.00 2,000
Total variance 176 F
Actual cost 800 1.90 1.20 1,824
 Variable direct costs variances

Total variance = 176 F

Material variance Volume Variance

Vol. Usage U.Price Cost

Budget 1,000 2.00 1.00 2,000

Tot. Variance 176F
Actual 800 1.90 1.20 1,824
 Flexed Budget
Vol. Usage U. Price Cost

Budget 1,000 2.00 1.00 2,000

Volume variance 400F
Flexed budget 800 2.00 1.00 1,600
Material variance -224U
Actual 800 1.90 1.20 1,824
Total variance 176F
Variable direct costs variances

Total variance = 176 F

Material variance Volume Variance

= 224 U = 400 F

Price Usage
variance variance
 Vol Usage U.Price Cost

Budget 1000 2,00 1,00 2 000

Volume variance 400 F
Flexed budget 800 2,00 1,00 1 600
Usage variance 80 F
Flex b. act. usage 800 1,90 1,00 1 520
Price variance -304 U
Actual 800 1,90 1,20 1 824
Total variance 176 F
Variable direct costs variances

Total variance = 176 F

Material variance Volume Variance

= 224 U = 400 F

Price Usage
variance variance
= 304 U = 80 F
 How to explain the variances?
• What may cause a favorable usage variance of 80?

• It may be linked to superior quality of raw materials,

improvements in the production process, etc.

• What may cause an unfavorable price variance of 304?

• It may reflect a poor performance of the purchasing department,

smaller quantities ordered (less discount), better quality of raw
materials, etc.

• What may cause a favorable volume variance of 400 ?

• It may be due to lower sales, production problems, economic

recession etc.

What corrective actions may be explored?

 Self-assessment question

Roach Limited planned to use 100kg of material at €5 per kg for

last week’s output. Although its production output was exactly as
planned, it used 110kg of material and paid only €4 per kg for it.
Calculate the material cost, price and usage variances.

Material cost variance = 110 x 4 – 100 x 5 = €60 F

Material usage variance = (100 – 110) x 5 = €50 U
Material price variance = (5 – 4) x 110 = €110 F
 Total variance = 60 F

Material variance Volume Variance

= 60 F =0

Price Usage
variance variance
= 110 F = 50 U
 Self-assessment question

Roach Limited has a small finishing department employing two

people. The budget showed they were expected to work for a total of
4,000 hours during the year just ended. The standard rate of pay
used was €6.50 per hour. The payroll shows they actually worked a
total of 4,100 hours and were paid a total of €26,650 to produce the
budgeted output. Calculate the direct labour cost, rate and efficiency
variances.

Direct labour cost variance = 4,000 x 6.5 – 26,650 = 650 U

Labour efficiency variance = (4,000 – 4,100) x 6.5 = 650 U
Labour rate variance = (6.5 - 26,650 / 4,100) x 4,100 = 0
 Idle time variance

Are quantity, price and volume var. covering all possible kinds of
variances?
Roach Limited has a direct labour budget for June’s planned output
of 2,000 hours at €10 per hour. Early in July it is found that the
planned output for June was achieved but 2,100 hours were
paid for at €11 per hour. However, no work could be done for
300 of the hours paid due to a failure in the just-in-time stock
control system. Calculate the appropriate variances.
Nbr of hours worked
Variance calculations:
Labour efficiency = (2,000 – 1,800) x 10 = 2,000 F
Idle time = - 300 x 10 = (1,800 – 2,100) x 10 = 3,000 U
Labour rate = (10 – 11) x 2,100 = 2,100 U
Labour cost variance = 2,000 x 10 – 2,100 x 11 = 3,100 U

Nbr of hours paid

 Fixed overhead variance

Roach Limited expects its total annual expenditure on fixed

overheads to be €180,000 and decides to spread this evenly
over its twelve accounting periods. If the amount actually spent
on fixed overheads in month 8 is €16,100, what is the fixed
overhead cost variance for that month?

Fixed overhead cost cost variance

= Budgeted fixed overhead – Actual fixed overhead
= 180,000 / 12 – 16,100 = 1,100 U
Design of a profit reconciliation statement
Original budget profit = 400
Sales volume variance = 31 F
Flexed budget profit = 431
Sales price variance = - 18 U
Labour:
Efficiency: = 2U
Idle time: = 12 U
Rate: = 14 F
Material:
Usage: = 39 F
Price: = 27 U
Variable overhead cost
Efficiency: = 1U
Expenditure: = 5F
Fixed overhead cost = 24 F
Actual profit = 453
The « Stanley » exercise
 Stanley & Co

Flexed budget (for 2,100 frames) €

Materials: 2,100 x 5.0m x €4.00/m = 10,500m x €4.00/m = 42,000
Labour: 2,100 x 0.50h x €12.00/h = 1,050h x €12.00/h = 12,600
Total = 54,600
Actual performance (for 2,100 frames)
Materials: 11,550m x €3.80/m = 43,890
Labour: 1,000h x €13.00/h = 13,000
Total = 56,890
 Stanley & Co

Variance calculations
€
Materials usage: (10,500 – 11,550) x 4.00 = 4,200 U
Materials price: (4.00 – 3.80) x 11,550 = 2,310 F
Materials cost: 42,000 – 43,890 = 1,890 U

Labour efficiency: (1,050 – 1,000) x 12.00 = 600 F

Labour rate: (12.00 – 13.00) x 1,000 = 1,000 U
Labour cost: 12,600 – 13,000 = 400 U
 Stanley & Co

Variance calculations
Possible explanations for variances

Materials usage = 4,200 U – wastage from poorer quality

materials
– wastage due to demotivated
workforce
– out-of-date standards
Materials price = 2,310 F – lower-priced substitute material
used
– unexpected discounts achieved
– lower prices from new supplier
– out-of-date standards
 Stanley & Co

Variance calculations
Possible explanations for variances

Labour efficiency = 600 F – motivated workforce due to pay rise

– more highly skilled type of labour used
– out-of-date standards
Labour rate = (1,000) U – recent pay rise (if not expected) or
higher pay rise than expected
– some overtime at premium rates may
have occured
– out-of-date standards
 Stanley & Co

1. Variance calculations
2. Possible explanations for variances
3. Amendments
The payment of idle time during the power cut affects the labour
efficiency variance only.

Labour efficiency: (1,050 – 950) x 12.00 = 1,200 F

Idle time: Idle time x Bugeted rate = -50 x 12.00 = 600 U
Combined = 600 F
The « Ivanblast » exercise
 Ivanblast Computer Game
Flexed Budget
Budget
Actual Sales standards Flex Budget
Vol. (in Unit) (£/Unit) £

Sales 30,000 50 1,500,000

Prod. Materials 30,000 1.1 33,000
Var.Ovhead 30,000 1 15,000
Fixed Ovhead 800,000
Profit 652,000

Sales Vol. Var 242,000F

Sales Price Var. 150,000U
Mat. Quantity Var. 275U
Mat. Price Var. 3,025F
Mat. Cost Var. 2,750F
Var. Ovhead cost Var. 0
Fixed Ovhead cost
Var. 50,000U
 Ivanblast Computer Game

INVANBLAST Profit Reconciliation Statement

Original Budget Profit 410,000

Sales Vol. Var. 242,000F
Flexed Budget Profit 652,000
Sales Price Var. (Flex. Budget Var.) 150,000A
Materials Usage 275A
Price 3,025F
Cost 2,750F
Var. Ohd. Cost var.
Fixed Ohd. Cost var. 50,000A
Actual Profit 454,750
 Ivanblast Computer Game

• The 10 % reduction in sales price seems to have paid off as

the number of games sold increased by 20 %. The net effect of
the sales volume and sales price variances is €92,000
favourable.
• 275 CDs were wasted. This could have been caused by
deciding to purchase CDs at a lower price (€1.00 as opposed to
€1.10) and lower quality. The favourable material price variance
of €3,025 shows that it was rather a good idea. On the other
hand, the material quantity variance may be the result of simply
not building normal production wastage into the budget. If so, this
planning error has now been revealed and should not be
repeated in future.
• The adverse fixed overhead expenditure variance of
€50,000 should not have occurred and should be investigated.
• The net result of the period’s activities is that the actual
profit is €44,750 (11%) greater than originally planned.